PROOF
Contents
List of Tables and Figures
xi
Acknowledgements
xii
List of Abbreviations
xiii
Introduction
xiv
1
2
Revenue Recognition
Introduction: Lucent Technologies
Revenue recognition methods and associated problems
Premature revenue recognition
The recognition of revenues without transferring the sale
risk of payment obligation: Sunbeam
Recognition of cost reductions as revenues: Ahold
Recognition of financial revenues as revenues of sales:
Parmalat
Recognition of taxes as sales: Heineken
Other techniques for recognizing revenues
Seven techniques for recognising fictitious revenues
Case study: recognition of revenues from sales of licenses
in the software industry
Case study: revenue recognition in the semiconductors
sector: ASML
How to detect doubtful revenues in company accounts
Applicable accounting standards
Impact of revenue recognition on the value of companies:
priceline.com
Conclusion
Stock Options: The Great Accounting Fallacy
Delta and Gamma: identical companies with different
accounting systems
What are stock options?
How to value stock options
A brief history of stock options
Why companies issue stock options
Why stock options are an expense
Impact of stock options on valuation
vii
1
1
3
8
12
13
13
14
14
16
17
22
23
24
25
27
29
29
30
32
33
36
37
37
PROOF
viii
Contents
Backdating
Conclusion
39
41
Off-balance-sheet Financing
The case of the banks
Factoring and credit sales in general
Changes in working capital: ACS
Obligations
Capital leases v. operating leases: synthetic leases
Sale and lease back operations
Unconsolidated entities
Parking of shares
Equity swapping
Special purposes entities
Case study: off-balance-sheet financing in the systems
integration industry
Guarantees
Securitization
Case study: off-balance-sheet financing in the banking sector
Epilogue: credit crisis and creative accounting
Conclusion
44
45
47
47
48
51
57
58
60
60
61
4
Risk Management, Derivatives and Hybrid Instruments
Publicis
Futures contracts: Deutsche Bank
Preferred stock: Balfour Beatty
Convertible shares
Reclassification of convertibles: ST Microelectronics
Mandatory convertibles: Adidas
Synthetic convertibles: Novartis
75
77
77
78
80
80
81
82
5
Recognition of Expenses, Balance Sheet Fluctuations,
Cash Flow and Quality of Earnings
Stock and inventory variations
Provisions in accounting
Recognizing amortization/depreciation
Extraordinary items
‘Pro forma’ accounts and dilution of earnings-per-share:
Proctor & Gamble
Capitalization of expenses
Deferred tax assets and liabilities
Alteration of short-term assets
3
64
64
65
67
70
71
84
85
88
92
93
94
96
98
101
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Contents
ix
Recognition of reserves: Royal Dutch Shell and Repsol
Pension funds
Cash flow
Case study: accounting in the film industry
Case study: the American International Group (AIG)
accounting scandal
Conclusion
101
102
104
106
6
Subjectivity in the Consolidation of Companies
Proportional or global consolidation: Ahold
Goodwill: Vivendi Universal
The equity method: L’Oreal
Provisions recorded during acquisition: ATOS
Conclusion
110
112
113
116
116
117
7
Creative Accounting in Public and Private Entities
Public entities
Parmalat
WorldCom
Enron
119
119
125
136
148
8
Conclusion
164
107
107
Notes
172
References
185
Bibliography
191
Index
193
PROOF
1
Revenue Recognition
When investors try to predict future cash flows and profits,
past performance becomes the foundation of credible forecasts.
Timothy M. Koller
McKinsey on Finance, summer 2003
Introduction: Lucent Technologies
In June 2004, the Securities and Exchange Commission (SEC) fined the
telecommunications equipment company Lucent US$25 million after
determining that, in 2000, it had incorrectly recognized sales valued
at US$1,148 million and earnings before taxes of US$479 million.1 In
its report, the SEC estimated that the company had inflated revenues to
complete certain internal sales increase objectives on which the variable
remuneration of its executives depended. To achieve these objectives,
‘some employees had violated and circumvented the company’s internal accounting controls’2 and had recorded certain products sent to
distributors as revenues, despite the fact that these were never sold to
end-consumers due to the significant deterioration of the balance sheets
of telecommunications operators at that time. A verbal arrangement had
been reached whereby distributors were allowed to return these products to Lucent, hence these could not be recorded as revenues.3 Figure
1.1 shows the evolution of the company’s stock price and the negative
impact the investigation and subsequent penalty had on its value.
In this chapter, we will look at how this type of aggressive interpretation
of when a sale is a sale is one of the most commonly used mechanisms
in creative accounting, and describe the most common techniques used
to manipulate company sales figures. The reader should keep in mind
that, despite the fact that in some cases these techniques are clearly
illegal, in other circumstances such mechanisms might be legal because
1
PROOF
2 Creative Accounting Exposed
Figure 1.1 Lucent Technologies stock price during the SEC investigation (25
March to 9 April 2004)
Source: Bloomberg.
they belong to so-called grey areas of accounting that can be interpreted
in different ways when it comes to recognizing revenues.
To begin this chapter, we will describe in detail the most common areas
in which doubtful sales are generated, in reference to acts such as recording revenues received in year 1 that actually correspond to future years,
recognizing revenues without transferring the sales risk, recording cost
reductions as sales, treating financial revenues as operating revenues
and recognizing as revenues taxes collected for payment to the Inland
Revenue Services. Examples will be provided of real companies that have
engaged in such practices.
We will then provide a more detailed and concise list of other legal
techniques for recognizing revenues followed by a list of illegal techniques for increasing sales revenues. Most of these techniques are also
presented in a schematic chart outlining the main problem areas associated with revenue recognition. After this list of examples, we will
approach the problem by focusing on two practical cases: one relating
to revenue recognition in the software industry and another concerning
the treatment of sales in the Dutch semiconductor company ASML. The
PROOF
Revenue Recognition
3
chapter concludes with a guide on to how to detect possible irregularities
in sales figures, details of applicable accounting regulations and some
reflections on the impact that the heterodox recognition of sales can
have on a company’s stock market value, illustrated by a practical case
study. Finally, there are some short conclusions on the reasons why
companies manipulate revenues and a possible solution to the problem.
Improper revenue recognition is one of the most important but, at the
same time, least studied aspects of creative accounting. In fact, between
1997 and 2001, 126 of the 227 enforcement matters brought by the
SEC regarding the quality of the financial statements of listed North
American companies – that is, around 40 per cent of the total – involved
the manipulation of revenue figures.4 The Treadway Commission, in its
1999 report on fraudulent accounting, established that more than 50
per cent of the cases of accounting manipulation between 1987 and
1997 were due to aggressive revenue recognition.5
Revenue recognition methods and associated problems
Two fundamental aspects must be borne in mind when considering
revenue recognition: timing, and the transfer of risk.
• Timing Imagine a grocer who purchases and pays a1,000 for some
lemons on 31 December and sells them in January for a1,250. If
cash-basis accounting is used, the expense is incurred in December
(and therefore a loss, because no revenues are recorded that month)
and the revenue (which is all profit) is generated in January. If the
most common accrual-based accounting method is used, the payment received for the merchandise does not prevent the recognition
of the corresponding expense from being deferred until the following
month and that therefore in January: sales are a1,250; costs a1,000;
and profits a250. Since cash flow and net profit are not the same over
the years, an increase in revenues recognized in the short term will
improve profit margins and, consequently, net profit in the current
year, at the expense of reducing future margins and profits.
Thus, the policy on timing of revenue recognition is crucial for
determining the future. Let us look at an example to illustrate this:
a kindergarten that offers nursery schooling for children aged one
to four charges a300 a month plus an enrolment fee of a900 when a
child enrols at the school. Let us assume that some parents enrol their
one-year-old baby on 1 January and pay the a900 enrolment fee and
the a300 corresponding to the first month. Should the kindergarten
recognize a1,200 of revenues in January or should it only record the
PROOF
4 Creative Accounting Exposed
monthly instalment of a300 and record the other a900 according to
the average period during which the baby is enrolled at the kindergarten? In other words, if most children spend an average of two
years at the kindergarten, should the kindergarten recognize a50 of
the a900 enrolment fee as first-year sales and the other a450 as sales
in year 2? Over two years, recognized sales are exactly the same: the
monthly instalment of a300 during 24 months plus a a900 enrolment fee gives a total of a8,100. Nevertheless, if the first method is
used, in the first year sales would be a300 × 12 months = a3,600, plus
the a900 enrolment fee, giving a total of a4,500; and in year 2 this
would only be a3,600. If the second method is used, in year 1 the
kindergarten would recognize a3,600 plus half of a900 (a450) – that
is, a4,050 – and in year 2, a4,050 once again. Although aggregate
profits in both years are the same with both methods, obviously with
the second method the same profit would be obtained in year 1 as in
year 2, hence, with the former, profits recognized in year 1 would be
higher and lower in year 2.
• The transfer of risk This concept implies that every sale in which the
merchandise risk has not been transferred is simply not a sale. For
example, if a newspaper sells its copies to kiosks and these have the
option to return unsold copies to the publishers at the end of each day,
the latter is not permitted to record copies distributed in the morning
at the kiosks as revenues but only those sold to end-consumers, since
the risk of no sale remains with the publishers and not the kiosk.
One way to approach the problem is to consider the company’s operative cycle when a sale is generated. This cycle normally involves the
following:
(a)
(b)
(c)
(d)
(e)
Receipt of the order;
Production of the good;
Delivery of the good or service to the client;
Invoicing the client and collection of payment;
Sometimes, after-sale service.
The accounting principle of accrual implies that revenues generated
from the sale of goods or services must be recognized when the actual
flow of the related goods and services occurs, regardless of when the
resulting monetary or financial flow arises. Therefore, one way of
bringing revenues forward is to increase or bring forward deliveries of
products or services to clients. Hence, the sooner a sale is recognized –
the times closest to point (a) – the more aggressive the company is; the
PROOF
Revenue Recognition
5
later the sale is recognized – that is, closer to point (e) – the more
conservative it is.
Using this approach to compare the revenue recognition policies of
different companies operating in the same sector can be very useful.
For example, in the Spanish construction sector civil buildings were
treated as sales when construction work had been technically or economically approved but before it had been certified. However, the
application of international accounting standards has brought about
important changes in practices within this sector because it is no longer
sufficient for construction work to have been completed, it must be
certified – that is, accepted by the customer – and this could have a serious impact on accepted revenue volume. To complete the example, the
recognition of the revenues of the insurance company providing civil
liability cover for the building is also highly subjective. Let us assume
that the insurance is contracted for a period of ten years. If the insurance
company recognized 10 per cent every year, it might be committing an
error – either intentionally or unintentionally – because the likelihood
of claims occurring normally increases as the building ages, so most of
the premium should really be recognized in these final years.
It is important to remember that the timing of revenue recognition
might depend on the accounting method applied by the company.6 In
the following sections, we will look at the most common methods.
Critical event method of revenue recognition at points of sale. Revenues are generated at a specific moment: for example, when an ice
cream seller gives a strawberry ice-lolly to a buyer. This system is mainly
used in the automobile, chemicals, consumption, distribution, media
and electricity sectors. For example, Renault recognizes its sales when it
delivers cars to its dealers.
Having said that, the critical event method of revenue recognition,
despite its simplicity, could give rise to subjective interpretation: My
Travel Plc, who sold package holidays for a price that included the
holiday and travel insurance, decided to recognize, at the time of the
transaction, the percentage of the package holiday sale price corresponding to travel insurance and to defer the rest of the sale price to
the moment when the holiday was actually taken; Rolls-Royce recognized subsidy payments – also called ‘launch aids’ for the development
of future products and normal payments in the aerospace industry –
as revenues.7 This accounting treatment could be incorrect; the problem lies in the fact that other companies in the sector recognize such
payments as liabilities and only record them as sales once the product
in question has been delivered; this makes it very difficult to compare
companies in the sector in terms of stock market multiples.8
PROOF
6 Creative Accounting Exposed
Percentage-of-completion method9 . This method is used for long-term
contracts and consists of calculating the percentages of estimated costs
that will be incurred to manufacture a good or render a service; these
percentages of the global amount of the contract are then applied to recognize the corresponding revenues in every year. This method is only
applied in some companies with long-term production periods such as
construction companies (for example, in the construction of tunnels or
motorways) or airplane manufacturers. As well as these two sectors, this
method is also used in the electrical engineering and telecommunications equipment sectors. Nokia, for example, applies this method in the
construction of mobile telecommunications networks. The subjectivity
resulting from the lax interpretation of the percentage-of-completion
method is broad. There are companies that, despite having short production cycles, apply this method to recognize prematurely revenues
that are actually deferred revenues that should be recorded, for accounting purposes, in future years. The other technique is when companies
are too aggressive in their quantification of percentages of completion.
Gamesa and the percentage-of-completion method
The Spanish engineering company Gamesa, when preparing its 2004
financial statements, applied the percentage-of-completion method to
recognize revenues obtained from its wind park sales aeronautical structures manufacturing activities, for which purpose three requirements
had to be satisfied: the duration of the operations generating the revenues had to be more than one accounting year; sufficient means and
controls had to have been implemented to enable reliable estimates to
be made; and there had to be no risk of the operation being cancelled.10
Until 2003, Gamesa used the policy of recording margins obtained in
wind park construction projects when these were actually sold, while
costs incurred in wind parks under construction were recorded in the
‘Inventories’ category. The company’s 2004 decision to adopt an alternative method for recognizing revenues was geared to reducing assets
and softening results in order to present a sustained growth of revenues,
perhaps in order to reduce share volatility.
Revenue allocation method. This is a combination of the two methods
described previously. One firm that employs this method is the German
software company SAP. When it concludes a licence sales agreement that
incorporates maintenance, it applies the critical event method to recognize the sale price of the licence, and the percentage-of-completion
method to recognize the amount received for maintenance and integration services. When the critical event and percentage-of-completion
PROOF
Revenue Recognition
7
Figure 1.2 Gamesa’s stock price during the accounting change between October
2004 and May 2005
Source: Bloomberg.
methods are combined, the revenue figure calculated using the critical event method is often inflated and the figure obtained with the
percentage-of-completion method reduced; this method is used very
often to increase short-term revenues and profits, as we will see in the
case of Xerox.
FIFA and the cash-basis accounting method
In 2003, the International Federation of Football Association (FIFA)
decided to adapt its accounting methods to the International Financial
Reporting Standards (IFRS).11 Until then, it had used the Swiss bookkeeping system of recognizing revenues and expenses on a cash basis;
in other words, it recognized sales when cash was received and expenses
when cash was paid. By switching to the IFRS standards, FIFA began
recognizing revenues in accordance with the accrual-basis accounting
method.12 FIFA was collecting revenues from the Word Cup that was to
be organized in Germany in 2006. Most of these revenues corresponded
to television broadcasting rights payable by different channels in the
form of royalties, which were fixed and determinable, plus a percentage
PROOF
8 Creative Accounting Exposed
of the profits to be obtained by these television channels. This percentage might vary according to the volume of advertisers. Switching to
the IFRS standards meant that FIFA began applying the percentage-ofcompletion method, allowing it to recognize revenues corresponding to
the percentage of profit and not to the royalty, if this was quantifiable
and probable. Notwithstanding the foregoing, the risk inherent in this
method is evident since it is conditioned by many highly volatile factors.
In particular, it is important to bear in mind that television channels
apply the critical-event method; they would only recognize revenues
and profits when the World Cup takes place. FIFA, on the other hand,
is already bringing revenues as yet unrecognized by the payers forward
to current years.13
In this brief introduction, we have looked at the problem of revenue
recognition and the impact that more conservative or more aggressive
interpretations might have on corporate financial statements. Let us
now look at the different revenue recognition policies that can be used
to manipulate revenue figures.
Premature revenue recognition
A multi-element contract is one in which a company undertakes both
to pay an amount for the purchase of a good and to render services
in the future or to make future improvements to the purchased good.
For example, the purchase of a car with a three-year guarantee is a
multi-element contract. Part of the price received by the seller is used
to purchase the car and the other part to cover the guarantee in the
agreed years: this type of contract can be easily manipulated by companies that increase the value of the good and reduce the value of the
service, thus maximizing profits recognized when the contract is signed.
In general, these contracts are normal in the software, systems integration and telecommunications equipment services industries. As we have
seen, this method might be open to subjective interpretation, which, in
some cases, could be abusive or improper. Now, let us look at some
examples.
Dixons
In 2004, the British distributor Dixons changed its policy for recognizing
revenues in respect of guarantees. Imagine a customer who purchases
a television set for £140 (real cost £80) and pays another £60 for an
extended guarantee for years 2 and 3 after the purchase of the product
(the first year is covered by the sale price of the television set). Let us
assume that the cost of this Dixons guarantee is £10 pounds per year
PROOF
Revenue Recognition
9
and that if it were to ask a third party to insure the risk, this would cost
£15 per year. In this scenario, it has three options:14
• It can recognize the £60 as income in year 1 (Dixons’ policy before
2004), and record a provision that year for the costs it expects to incur
in years 1 to 3; thus, all profits from the transaction are generated in
year 1.
• It can defer the full amount of revenue obtained in respect of the
guarantee (Dixons’ policy after 2004); thus, the sales corresponding
to the £60 guarantee and the corresponding profits are recognized in
years 2 and 3.
• It can recognize, of the £60 of revenues relating to the guarantee, £30
in year 1 and defer £15 in each of years 2 and 3; that is, deferring the
amount that Dixons would have to pay when transferring the risk.
Thus, with the first method, the company would recognize sales of £200
in year 1, £100 in costs (including £20 of provisions), giving a profit of
£100. If it were to use the second method, it would obtain year 1 sales
of £140 (£60 profit) and £30 in sales in each of years 2 and 3, with £20
pounds. If it were to opt for the third method, year 1 sales would be
£170 (a profit of £90 since the cost of the guarantee would be deferred),
and £15 in revenue and £10 in costs in each of years 2 and 3 (£5 profit
in each year).
The new bookkeeping method applied by Dixons in 2004 reduced
equity by £357.5 million (21 per cent of the total); in the year prior
to the year in which the aggressive bookkeeping technique was used,
profits were inflated by £357.5 million and operating revenues by £510.8
million.15
Xerox Corporation
On 6 February 2001, The Wall Street Journal published a long article that
analyzed the abusive accounting practice of Xerox, which had the habit
of recognizing leasing payments as sales. In April 2002, after an investigation by the SEC, the American company was forced to reclassify
its financial statements for the years 1997 to 2000 and reduce recognized revenues by US$3,000 million and profits by US$1,500 million,
with equity being reduced in the same amount.16 As a result, the SEC
fined Xerox US$10 million. By that time, the price of the company’s
shares had plummeted from US$62 to US$4.5.17 How did this company
manipulate its revenue figures?18
Xerox sold customers photocopiers under long-term agreements, in
which the customers paid a sum of money to Xerox, part of which
PROOF
10 Creative Accounting Exposed
Figure 1.3
Evolution of the Xerox’s stock price
Source: Bloomberg.
was to purchase the machine and the other part to cover repairs and
maintenance on a long-term basis. This was not problematic in itself
from a bookkeeping perspective, provided that the amount corresponding to the sale price of the machine was recognized as revenue in the
first year, plus revenues corresponding to maintenance services in the
current year, transferring the rest of the received amount to deferred
revenues, which, in turn, were recorded as sales in the year in which
the repair services were rendered.
So, if a photocopier, for example, is valued at US$100, and five-year
maintenance costs US$50, the customer would pay Xerox US$150 when
purchasing the machine. The correct accounting method for recording this operation, if the transaction were performed on 1 January,
would be to recognize US$110 of sales in year 1 and US$10 of sales
in each of the following four years. Accounting malpractice on the part
of Xerox consisted in recognizing US$125 of revenues from the sale of
the machine, thus undervaluing the amount of future repair services,
recording US$130 as revenues in year 1 and deferring only US$20 over
the remaining four years of the contract. In this way, it increased year 1
profits substantially and reduced future profits. The total amount of the
PROOF
Revenue Recognition
11
transaction in sales remained the same (US$150); the problem is simply
the timing of the recognition of these sales.
Vodafone
Let us now look at another problematic case of premature revenue recognition. A customer visits a department store and contracts a mobile
telephone with Vodafone, paying a150 to register. Does this a150 correspond to sales that should be recognized immediately or should they
be deferred over the average estimated life of the customer relationship? Under Spanish or British accounting standards, Vodafone España
and its parent company Vodafone Plc are required to recognize the
a150 as sales in year 1. However, their revenues under North American
accounting standards would be lower than those presented under British
or Spanish accounting standards since North American bookkeeping
standards require companies to defer revenues corresponding to customer registrations over the average estimated life of the customer
relationship.
In 2002, Vodafone declared revenues of US$32,554 million according to British accounting standards.19 Since the company is listed on
the New York stock exchange, it is also required to file accounts in
accordance with American bookkeeping standards. Surprisingly, in its
American accounts it reported US$25,136 million in revenues, almost
20 per cent less than in its British accounts! Why did Vodafone’s sales
differ according to the accounting standard applied? Well, on the one
hand, British accounting standards allow the company globally to consolidate subsidiaries whose boards of directors are effectively controlled
by the company, even if it does not own more than 51 per cent of the
subsidiary. However, under American accounting standards the company can only fully consolidate subsidiaries in which the company has
more than a 50 per cent shareholding. Since the scope of consolidation varies, the consolidated revenues figure also varies. On the other
hand, under British accounting standards, registration fees must be recognized when the customer is registered; that is, the date he/she pays
the registration fee or on a nearby date. The reason for this is because
registration fees are not considered to be sales. Under US GAAP, they
are recognized as revenues according to the average expected life of
the customer’s relationship with the company. In the case of Vodafone,
this is assumed to be an average of four years. Without attempting to
determine which of the two solutions is correct, it is interesting to note
that the impact on cost allocation might also vary depending on which
method is applied.20
PROOF
12 Creative Accounting Exposed
Telefónica Móviles
The same accounting effect applies to the Spanish mobile telephony
operator Telefónica Móviles. When the company switched to the IFRS
accounting standards, this did not only entail a change in the accounting of registration fees but also equipment sales, which under Spanish
accounting standards were recorded when they were sold to distributors.
Under the IFRS, they were only taken into account when the equipment had been sold to the end-consumer. As result of this switch, the
telephony operator’s profits would have been reduced, in 2004, by a7.1
million, and the impact on the values recorded in the company’s balance
sheets would have been a reduction of a30.8 million.
Recognition of bank revenues (Banesto and Bankinter)
It is very common for financial entities to perform interest rate swap
transactions (by paying fixed interest and receiving variable interest,
or vice versa) or foreign currency swap transactions. Sometimes, these
types of contracts generate revenues if the underlying risk is transferred
to the financial entity. The problem is the point at which these revenues should be recognized. Banesto recognizes them at the end of the
accounting year, regardless of when the contract ends. Bankinter waits
until the contract ends before recognizing these revenues. Both systems
are perfectly legal; in the case of Banesto, the bank uses this method to
bring forward the recognition of income.
The recognition of revenues without transferring
the sale risk or payment obligation: Sunbeam
Sunbeam, a company that sold gas grills, recognized sales invoiced to
distributors with which it had no risk commitment as revenues; that is
to say, these distributors would return to Sunbeam all goods not sold at
their establishments within a given period. Technically speaking, such
deliveries of goods should not have been recognized as sales because
the risk was still assumed by Sunbeam and not the distributor. If the
risk of the merchandise had been transferred to the end-consumer, it
would have been correct to recognize these sales as revenues. Hence,
when distributors returned unsold products to Sunbeam, the latter proceeded to cancel these sales. In 1998, the SEC discovered that rights
of return existed in the case of US$24.7 million of sales recognized in
the fourth quarter of 1997; that is, they were sales without any economic impact that should not have been recognized.21 The charismatic
Managing Director of Sunbeam, Al Dunlap, was fined US$15 million
PROOF
Revenue Recognition
13
by the SEC for endorsing and instigating such practices, and he was
prohibited from occupying an executive position in any North American company for the rest of his life. Sunbeam is now a subsidiary of
American Household, Inc.22
Recognition of cost reductions as revenues: Ahold
In the Ahold supermarket chain, a series of irregularities in the revenue
figures of a North American branch led to accounting manipulations.
The supermarkets receive discounts – in cash or in credit, to purchase
more merchandise free – from suppliers when they achieve certain
sales targets. These discounts should have been treated as reductions
of sales costs. However, the branch incorrectly recognized these discounts as revenues.23 Furthermore, they were also recognized before
they should have been. The Financial Accounting Standards Board
(FASB)24 has established that these types of discounts must be treated as
follows:
• If they are received at the beginning and in cash, the costs of the
purchased materials have to be reduced by the amount of discount at
the time of the sale; in the meantime, they have to be deferred
• If the cash amount is received after the sales target has been reached,
the cost of the materials must be systematically reduced according to
the percentage of purchases made from the seller
• Only if the cash amount is received at the beginning and is irreversible
(it does not have to be returned) can it be recognized immediately as
a reduction in sales costs.
In the case of the Ahold subsidiary, the discounts were not irreversible
because they depended on the attainment of the sales objective but were
nevertheless recognized immediately instead of being deferred.25
Recognition of financial revenues as revenues of
sales: Parmalat
Revenues generated in financial operations, such as securities purchase
operations, or even profits obtained in derivatives transactions, should
always be recognized as financial revenues and must not be recorded
with operating profits. However, some companies have recognized these
revenues as ‘other revenues’ in the same sales bracket. The impact of
this fraudulent recognition of revenues is enormous because financial
revenues, if recognized as ‘other operating revenues’, inflate operating
PROOF
14 Creative Accounting Exposed
margins artificially. Thus, if a company with sales valued at a100 and
operating profits of a20 fraudulently recognizes financial revenues in
the amount of a10 as ‘other revenues’, sales would amount to a110 but
operating profits would increase to a30, so the margin would rise from
20 per cent to 30 per cent!
Let us look at an example to illustrate the problem. In 2003, Parmalat
recognized a40.7 million in financial revenues as ‘other sales’, equivalent to the first payment received as part of a financial swap deal. In
2002, the company recorded as ‘other sales’ revenues generated from
the sale of products such as ice creams, water, chocolate, sports activities, fruit juices, butter and cheese.26 However, the financial difficulties
experienced by the company in 2003 prompted it to reclassify the supposed financial revenues obtained under the swap deal as operating
revenues in the third quarter of 2003, giving an operating margin of
8.3 per cent, when it was really 7.6 per cent.27 As we will see later, Parlamat’s former Financial Officer and former Chairman were sentenced
to prison for engaging in such accounting practices. This showed that
their actions were not just illegal and unethical but also violations that
were punished as criminal offences (imprisonment) and with penalties
that affected equity (heavy personal and corporate fines).
Recognition of taxes as sales: Heineken
The brewer Heineken changed its revenue recognition policy when filing its accounts for the first six months of 2003. It no longer treated
sales collected as taxes on alcohol as revenues.28 This reduced revenues
by 12 per cent, obviously without affecting net earnings. In 2001, the
Belgian brewer Interbrew recorded the same entry, which is a requirement under international accounting standards, reducing its sales by 30
per cent to a5,600 million.29
Other techniques for recognizing revenues30
• Sending goods to clients without these having been ordered beforehand. The
accounting entry is corrected when the ‘error’ is discovered, but the
error is normally notified in the accounting period after the one that
concerned the company.
• Renting warehouses to send products there and recognize them as sales.
Returning to the case of Sunbeam, this company convinced its distributors to purchase grills six months before the season was due to
begin in exchange for important discounts. The merchandise was not
PROOF
Revenue Recognition
•
•
•
•
•
•
•
15
delivered until six months later and the price would not be collected
before that date. In order not to wait half a year to recognize the sales,
Sunbeam sent its merchandise from its Neosho factory in Missouri to
different third-party warehouses rented by the company where the
merchandise would be stored for six months until delivery. Thus,
Sunbeam recognized US$35 million as sales; later, however, independent external auditors declared that US$29 million of these sales were
fictitious.31
Recognizing, as revenues, orders received from customers for certain products
when these have not yet been sent.
Keeping the sales order book open in January but recognizing these sales in
December by recording invoices issued previously.
Manipulating the end-of-quarter figure (Sunbeam decided to postpone
closure from 29 March to 31 March).
Selling products through loans granted to clients on a recurrent basis to
pay for products, with these sales accounting for a high percentage
of total sales. At the end of 2000, telecommunications equipment
companies granted US$15,000 million of financing to operators so
that they could continue buying their products. What they were really
doing was buying their own products from themselves.
Accelerating sales by offering extended payment periods if new products
are acquired by means of third party financing to obtain cash revenues
in less than twelve months.
Recognizing revenues despite having serious doubts about the solvency of
customers due to their financial situation or repayment capacity, or to
the lack of a sufficiently solid source of financing. It is important to
remember that under the new international accounting standards,
revenues can only be recognized if the customer is deemed to be
capable of repaying the loan (or when the customer has received the
correct type of financing). In other words, it is not permitted to recognize revenues and record an insolvency provision. If there are serious
doubts regarding the collectibility of the sale in question, the sale
must not be recognized.
Carrying out bilateral transactions between strategic partners. The revenues reported by the Spanish satellite TV company Sogecable for
the first quarter of 2005 were up 4 per cent to a396.4 million. When
Telefónica – in turn one of Sogecable’s two major shareholders – was
awarded the contract to broadcast the Spanish Soccer League on its
pay-per-view ADSL television platform Imagenio, Sogecable obtained
around a25 million in revenues. This contract increased revenues
dramatically by 37 per cent to a107 million and compensated for
the 6 per cent downturn in subscriber revenues, Sogecable’s core
PROOF
16 Creative Accounting Exposed
area of business.32 The North American company Healtheon signed
a five-year collaboration agreement with Microsoft under which it
undertook to purchase software packages from the software giant
for US$162 million; in return, Microsoft would pay Healtheon the
first US$100 million in advertising on three of Microsoft’s thematic
channels.
• Recognizing inflated revenues corresponding to consideration with additional economic value (for example, by selling something worth
US$100 for US$200, by inviting customers to overpay US$100 for
a gift or consideration). Broadcom, before completing an acquisition,
would convince the acquired company to obtain purchase commitments from customers in exchange for warrants on Broadcom’s
stocks. When the warrant stocks were issued, the resulting goodwill
was redeemed over 40 years while generated revenues were recorded
in the following year. Thus, if Broadcom received orders for the
value of US$1,000 and it committed a warrant valued at US$250, the
real amount of revenue was US$750 and not US$1,000. What customers were actually doing was only paying for the net portion of
the warrant.
• Recognizing extraordinary revenues as ordinary revenues, such as profits from property sales recorded by a non-real estate company. Once
again, the impact of this fraudulent practice on operating margins is
enormous.
Seven techniques for recognizing fictitious revenues33
• Invoicing false customers.
• Recognizing sales without the customer making a commitment to pay for
the delivered product.
• Sales conditioned by future events. This can be achieved by invoicing
the product sent to a customer where full approval of the purchase
still depends on an additional formality. This formality is established
in so-called ‘side letters’. For example, HBO & Co. sold software to
hospitals by issuing an additional letter that established a condition
for the sale: approval by the hospital’s board. However, the company
recognized the revenue despite North American accounting standards
requiring all the conditions to have been fulfilled before such revenues could be recorded. Bausch & Lomb used a similar technique. On
19 December 1994, Business Week revealed the accounting tricks used
by this contact lenses firm, which persuaded distributors to purchase
a total volume equivalent to two years’ worth of stocks, at inflated
prices, before 24 December 1993, the date on which it closed its
PROOF
Revenue Recognition
•
•
•
•
17
books. The company generated orders valued at US$25 million, yielding US$7.5 million in profits, the same as those obtained in 1993.
In 1994, this practice produced an inventory excess at distributors,
which reduced orders substantially. As a result, that year’s income
also fell sharply, with stocks falling from US$50 to US$30. Eventually, Bausch & Lomb only collected 15 per cent of the sales generated
at year-end 1993, since these were conditional upon the lenses being
sold, in turn, by the distributors and this did not happen.
Recognizing, as revenues, discounts offered by suppliers linked to future purchase undertakings. These are contracts under which customers agree
to overpay for certain goods now if the seller agrees to repay this extra
amount later in the form of a cash payment. This cash payment is not
a sale but a purchase refund; thus, the costs of materials are reduced
by diminishing the value of stocks. However, some distributors treat
these as sales in order to thus increase their turnover.
Recognizing sales that are incorrectly deferred during a merger process.
When a merger is announced, one of the companies is instructed
to defer the recognition of sales until after the merger has been concluded in order to improve comparisons and achieve the promised
revenue synergies; in the merger between 3Com and US Robotics,
US$600 million of sales were not recognized for two months so that
they could be recorded after the merger had taken place.
Distributing goods to other company warehouses that are invoiced as
customer revenues by mistake.
Selling goods to participated companies with an agreement to repurchase
these goods in the future. This practice is particularly relevant in the
case of strategic partners.
Case study: recognition of revenues from sales of
licences in the software industry
The revenues of software companies normally include licences, maintenance (technical support and licence renewals with state-of-the-art
packages or upgrades) and service (integration and training). The sale of
licences and the rendering of services and maintenance during the first
year are normally recognized in the quarter in which the transaction is
performed; the rest is recorded as deferred revenue, against which an
obligation must be recognized as established in the signed agreement.
Receivables must also be considered since many software companies
lease their products to customers under financial leasing arrangements
through third parties, normally financial entities, in without-recourse
PROOF
18
Table 1.1
Problematic areas in the recognition of sales1
Area
Recommendation
Sales returns
The invoiced sales figure must be reduced.
Non-recurrent fee
obtained for a
recurrent risk
If the recurrence of the risk corresponds to a fixed
period, the fee must be recognized as deferred
revenue in this period. If it corresponds to an
indefinite period, the fee may be recognized as
year-1 revenue if the company does not have to
provide any service in the future; if it does have
to render services, then the recognition of this
revenue must be deferred. If the customer has to
pay the fee, the regular payments and future
revenues also cover future costs; then, the initial
fee may be recognized as revenue.
Cash discount (prompt
payment discount)
These discounts do not affect the value of
the sale unless they appear on the invoice
since the payment conditions do not alter
the invoiced amount. The discount is normally
a financial cost.
Exchange or barter
transactions (transactions
performed by similar
companies exchanging
products; for example,
two newspapers that
exchange adverts)
For these transactions to be recognized as
revenues (for example, in the case of two
newspapers), there must be persuasive evidence
that, if the advertising had not been exchanged,
it could have been sold in cash in a similar
transaction with another client. This rule applies
to all exchanges in general.
Delivery costs invoiced
to customers
These costs may be recognized as revenues
provided their associated costs are recognized
in the same accounting period.
IRUs (indefeasible rights
of usage) on
telecommunications
sector assets
These are normal arrangements that affect
unused fibre optic capacity with regard to the
acquired total. Problems arise when these rights
are resold to the same company that had
initially sold them without any cash exchanging
hands (these arrangements are known as ‘hollow
swaps’). The accounting principle applied in such
cases should be similar to the one applicable to
barter transactions. If the contract is equivalent
to a long-term lease, total revenues may only be
recognized in the case of a capital lease and not
an operating lease; that is, a lease in which the
risk and profits resulting from ownership of the
asset have been transferred.
(Continued )
PROOF
19
Table 1.1
(Continued)
Area
Recommendation
Gross or net sale (excluding
fees) by an agent
An agent may only recognize, as revenue,
the fee obtained from the sale of a good if the
agent assumes the risks associated with not
selling the good. The gross amount of the sale,
and not just the fee, may only be treated as
revenue if the agent does not sell the good and
assumes the risk of owning that good. According
to this rule, a travel agency cannot record the
total amount of an air ticket sold to a private
customer as revenue, only its fee, because the
risk of the airplane taking off with empty seats
must be assumed by the airline and
not the agent.
Defaulted credit
Under international accounting standards, a
provision must be recorded for any defaulted
credit detected and the corresponding amount
will increase the sales cost.
Long-term receivables
The logical thing to do is to recognize the
current value of these accounts in the balance
sheet and not the total value, and, in each
accounting period, to increase the amount
corresponding to this asset with the financial
revenues account in the profit and loss account.
Transactions without
physical entry of the item
(‘channel stuffing’ and
‘billing and holding’): a
customer agrees to buy a
good but the physical
owner is still the seller until
the place where the item is
to be delivered is specified
In the case of trial products with a right of
return, the sale cannot be recognized. For sales
to be recognized as revenues in such cases,
the following requirements must be
satisfied:
• The risk must have been transferred (that is,
there is no right of return)
• The purchase commitment is strong
• The customer has a reason for ordering the
item and it has not yet been delivered to the
customer
• The shipment date is fixed
• The sale is complete and is not subject to any
future condition
• The goods are finished products.
1
Peter Suozzo et al., ‘Can You Trust the Numbers?’, UBS Investment Bank, March 2002,
p. 27.
PROOF
20 Creative Accounting Exposed
transactions; that is, if the customer does not pay, the financial entity
cannot lodge a claim against the software company, but it can in transactions in which a defective software package might give rise to liability
on the part of the manufacturer.
Two methods can be distinguished in this case: the sell-in revenue
method, in which the product is delivered to a distributor; and the sellthrough revenue method, in which, as its name suggests, the products
are delivered to the end-consumer. Both methods are permitted, but the
second obviously implies better-quality revenues because these correspond to sales to end-consumers, whereas the first method only implies
sales to an intermediary, in this case a distributor. In the software sector
revenues can only be recognized if the fee is fixed, and this is presumed
not to be the case if the payment has to be made at least twelve months
after the software is delivered (FAS).34
To limit abuse of the lax accounting regulations, the United States
issued Statement of Position (SOP) 97-2, Software Revenue Recognition,
which established the specific requirements to be satisfied by software companies for recognizing software revenue. This standard, which
was introduced in 1997 and modified in 1999, not only established
these requirements but also later served as the legal framework regulating the recognition of sales in general.35 SOP 97-2 established that
four criteria must be met prior to recognizing revenue; persuasive evidence of an arrangement; delivery must have occurred or the service
rendered; the vendor’s fee must be fixed or determinable; and collectibility must be probable.36 In any case, constant abuse within the sector
through the use of multi-element arrangements forced the issuance of
another accounting standard, the EIFT 00-21 (Revenue Arrangements
with Multiple Deliverables),37 specifically applicable to the software
sector. This standard prohibits the recognition of sales between associated companies (related parties), the recognition of revenues from
licences deemed to be premature (not yet terminated) and sales transactions in which payment has been guaranteed by the actual seller.38 This
standard prohibits the application of the percentage-of-completion criterion to the sale as a whole. Instead, it stipulates that these contracts
must be divided into separate transactions, thus reducing accountants’
discretion (one transaction accounting for the sale of the software package and another one accounting for the maintenance service); once
both elements of the contract have been distinguished, the criteria
established in accountancy standards for recognizing revenues can be
applied. Moreover, the standard does not initially allow revenues to
be recognized in respect of services rendered until the systems or services have been completed. This method even prohibits companies
PROOF
Revenue Recognition
21
from recognizing unbilled receivables, although, to compensate, it does
permit the amortization of costs incurred in long-term arrangements.
Lastly, the standard makes it obligatory for companies to provide details
of the accounting policy used in these types of arrangements and the
clauses established in the corresponding contracts. As a consequence
of the application of this standard, in the fourth quarter of 2002 Perot
Systems was forced to reduce its expected profits for the year by US$14
million; that is, 50 per cent.39
After American firms were obliged to adapt to this accounting standard, which produced more losses at the beginning of contracts than
with the percentage-of-completion method, while European companies
were not so obliged, the latter were able to capture market shares in contracts that generated profits under international accounting standards
and losses under the American system.40
We will now look at three case studies to exemplify manipulation in
revenue recognition.
BAAN
The Dutch software company BAAN enjoyed great success in the mid1990s. When its sales started dropping off, BAAN decided to apply
more aggressive revenue recognition criteria. It started invoicing new
products that had not yet been completed that were sold to customers,
who obviously received them much later than agreed. It also recognized US$43 million in revenues from the sale of systems to its own
distribution company, basically an intra-group sale. In April 1998, the
auditors refused to sign BAAN’s accounts, forcing the company to issue
a profit warning to the market that it would not be able to meet its
profit estimates. These events prompted customers to abandon BAAN
for more rigorous companies and eventually marked the end of BAAN
as an independent company.41
EDS
In January 2003, the SEC began investigating the accounts of this North
American technology company. In October that year, as a result of
this investigation, EDS was forced to reduce revenues recognized in
2001 and 2002 by US$2,900 million corresponding to non-invoiced
sales and US$400 million in incurred losses and to defer US$1,100
million in system construction costs. In net terms, EDS had to face a
charge of US$2,240 million of losses before taxes as consequence of this
accounting regularization brought about by the improper use of the
percentage-of-completion method.42
PROOF
22 Creative Accounting Exposed
Microstrategy
On 20 March 2000, as consequence of the application of the restrictive
SOP 97-2 statement applicable to software companies, Microstrategy
was obliged to reduce its 1999 sales by US$50 million (25 per cent of the
total); as a result, its declared profits for the year of 15 cents per share
were transformed into a loss of 44 cents per share, meaning its shares
dive-bombed 60 per cent that day. Microstrategy was listed on the stock
exchange in 1998 and had applied very aggressive criteria in 1999 to
support the operation, prematurely recognizing revenues corresponding
to services that were to be rendered in the long term, or even recognizing
revenues on contracts that had not yet been signed. The directors were
hit with a US$11 million fine.43
Finally, we will compare three British companies that sell software
licences. London Bridge Plc carries out short-term contracts (about six
months) and recognizes revenues at the beginning of each contract,
an aggressive but nevertheless legal approach to recognizing revenues.
Marlborough Stirling Plc adopts a neutral policy; its contracts are
long-term (24 months) and it recognizes part of the arrangement as
revenue when the contract is signed, invoicing the rest over the term
of the contract. The third company, Alphameric, employs a very conservative approach by recognizing all revenues six months after the
software licence is implemented to ensure that any problems arising
after this date are resolved correctly (with the corresponding costs clearly
valued).44 The three companies apply perfectly legal accounting criteria
but obviously the quality of their revenues is extremely diverse.
Case study: revenue recognition in the
semiconductors sector: ASML
ASML is a Dutch company that manufactures semiconductor equipment. It reported revenues of a1,960 million in 2002, up 23 per cent
on the previous year. However, of that increase 9 per cent (a138 million) was due to a change in its accounting criteria. ASML makes a
distinction between revenues from new and tested technology, adopting
different criteria to recognize revenues from each type of technology.
For tested technology, it recognizes revenues when the product is sent
to the client since the latter becomes the owner when it has accepted
the system unconditionally during a test performed at ASML’s factory
prior to delivery. New technology, however, is not recognized as revenue until the equipment has been installed and accepted at the client’s
factory. Once the equipment has been operating normally for a certain
PROOF
Revenue Recognition
23
period, this new technology is recognized by reclassification as tested
technology, and any revenues perceived for such equipment, recorded
in the balance sheets as deferred income, are then carried over to sales.
In the second half of 2002, ASML Twinscam’s technology, which had
previously been classified as new technology, was reclassified as tested
technology, increasing 2002 revenues by a138 million. This reclassification in itself was not abusive (it affected 13 of Twinscam’s 70 installed
systems), but it should be studied in depth by analysts since it accounted
for a large part of the company’s increase in turnover that year (specifically 9 per cent of 23 per cent; in other words, without the change in
accounting criteria, the company would have increased its revenues by
14 per cent, and not 23 per cent).45
How to detect doubtful revenues in company accounts46
• Identify variations in returned sales accounts; the percentage of returned
•
•
•
•
•
sales with respect to total sales should be stable in ordinary circumstances.
Calculate whether operating cash is much lower than net income.47
Look for changes in accounting policies without the appropriate adjustments having been made in previous years, since this hinders organic
comparisons.
Determine whether receivables have increased in a larger proportion to
revenues. If long-term revenues receivable increase dramatically, this
means that the company is recognizing revenues payable more than
twelve months later, which might suggest it is recognizing revenues
prematurely.
Determine whether unbilled receivables48 increase much faster than billed
receivables.49
Make sure that the product has been delivered before the end of the
accounting period and that it cannot be returned.
In general, increases in unbilled receivables with respect to billed
receivables suggest that there is a high risk that the company might
issue a profit warning to the market, since such increases are normally
the result of the company prematurely recognizing revenues using very
aggressive criteria, without replacing these with better revenues in the
future. This system allows the company to resolve the current year at
the expense of disappointing shareholders and investors the following
year.50 The same can be said of receivables. A sharp increase in receivables could imply that the company is unable to collect its sales; this
might occur because the company, in its desire to boost sales, provides
PROOF
24 Creative Accounting Exposed
services or sells goods to clients who are unlikely to be able to meet
their payment commitments. It might also be a sign that the company
is using the so-called ‘jockey stick’ effect, which consists of bringing
forward sales from the following year to the current year. Clients are
normally asked to place orders today instead of tomorrow in exchange
for discounts. This allows the company to reach its sales objectives for
the current year, at the expense of profits. Once again, if future sales are
not replaced, the risk of disappointing the market in the mid-term is
enormous.51 The problem is that, in practice, it is virtually impossible
to detect such accounting behaviour.
Applicable accounting standards
The North American accounting system (US General Accepted Accounting Principles (GAAP), or accounting standards) establishes that revenues ‘must not be recognized until they are realized or realizable’, and
later stipulates ‘that revenues are considered to have been earned when
the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues’ and that ‘if services are
rendered . . . reliable measures based on contractual prices established in
advance are commonly available, and revenues may be recognized as
earned as time passes’.
Since these standards are fairly vague, in December 1999 the SEC introduced the SAB 101 standard, applicable as from the fourth quarter of
2000, which developed the GAAP through practical cases (10 case studies). It established four principles that had to concur in time in order for
a sale to be recognized as such:
• Persuasive evidence (oral or written) that the sale- purchase agreement has
been concluded (to avoid excessive deliveries of products to customers,
or channel stuffing, as we saw in the case of Sunbeam or Bausch &
Lomb).
• The item must have been sent or the service rendered; this means that
neither registration fees nor initial payments can be recognized as revenues but must be spread over the useful life of the contract; hence,
Telefónica or Vodafone cannot recognize registration fees as revenues
in the United States. Nevertheless, in transactions in which the customer has ordered the product but prefers to wait to receive it – that is,
bill and hold – such fees or payments can be recognized as revenues,
in accordance with the strict conditions explained above. Following
the introduction of this rule, under American accounting standards
PROOF
Revenue Recognition
25
the French pharmaceutical company Sanofi was forced to stop recognizing as revenues the payments it received as rights for the use of its
technology for medical research.
• The price must be fixed or objectively determinable (to avoid barter
or exchange transactions in which, as we saw earlier, companies
exchange similar goods – for example, adverts between two newspapers, without the exchange ever taking place, in order to increase
revenues).
• The collectibiity of the good or service must be reasonably guaranteed; this
prevents the recognition of sales that are still due after more than
twelve months, or payments from customers who are unlikely to be
able to meet their payment commitments, meaning that they are
granted exceptional invoicing conditions).52
In contrast to North American accounting standards, which are very
focused on practical cases, international accounting standards, specifically Standard IFRS53 18 of 1982, which was revised in 1993, are more
conceptual. This establishes that revenues can only be recognized if
there is sufficient evidence that there has been a change between assets
and liabilities – that is, that the item has been delivered or the service
rendered – and also that such changes can be measured objectively.54
Following the application of these standards, Spanish property companies – which, under the Spanish accounting system, were allowed to
recognize revenues from new constructions when sale–purchase agreements were realized and 80 per cent of housing construction costs
incurred – could now only recognize, as revenues, housing that had
been signed with and handed over to buyers, prompting substantial
reductions in revenues recognized by these companies.
Given the current scenario, North American and international
accounting institutions are currently working on the idea of issuing a
common global accounting standard to ensure greater coherence with
a view to a future merger of both accounting systems.
Impact of revenue recognition on the value of
companies: priceline.com
We have seen how the subjectivity of revenue recognition does not normally affect sales or profits from a long-term standpoint. Seen from
this perspective, one might think that such practices would not have
any impact on the value of companies, but that is incorrect. Let us
see why.
PROOF
26 Creative Accounting Exposed
Analysts make their cash flow forecasts based on current year figures;
hence, overestimating margins in a given year in which a company
reports, say, an operating margin of 15 per cent, could prompt the analysts who failed to picked up on this aggressive recognition of revenues
to issue similar projections in future years, and particularly indefinitely
when making cash flow discounts. Such errors might inflate the value
of the company we wish to analyze.
The impact on market multiples can also be extremely significant.
Thus, if we were to compare two companies by applying the mean price
earning ratio (PER) for the sector in the current year to each company,
and if one company recognized revenues – and, therefore, profits – more
aggressively than the other company, and if we did not exclude extraordinary income produced by accounting manipulations, we would be
prejudicing the more conservative company. Despite falling into disuse, multiples that measure the market value55 of companies according
to their turnover – or, even worse, multiples that measure market capitalization based on turnover, which are even more inappropriate and
vulgar in nature – can be altered by manipulating revenues figures.
The case of Priceline (priceline.com) is well known. This was one of the
first online travel agents to be listed on the stock exchange. Aware that
there were hardly any other travel companies operating on the Internet
in 1998, Priceline determined its accounting criterion for recognizing
revenues. Instead of recording the commission the agencies charged
on air tickets sold to customers as revenues, and before the company
was listed on the stock exchange, it decided that its sales would correspond to the total sale price of tickets, the cost of the sales being the
percentage that was collected by the airlines. This had no impact on
profits. However, this simple procedure allowed Priceline to multiply
its revenues, thus increasing the IPO proceeds since these were based in
a capitalization multiple for sales. It is always important to remember
who assumes the inventory risk (the transfer of the good or service). If
the agency does not sell the ticket, its accounts will not be adversely
affected. However, this is not true in the case of the air carrier because
the seat remains empty when the airplane takes off. This risk transfer
criterion, also mentioned in reference to Sunbeam, should provide us
with a solid reference for recognizing when a sale is really a sale.
These problems mainly arise when the person handling figures at a
company is unaware of the different accounting methods that can be
applied in order to recognize revenues. Strong increases in sales, better
profit margins and high income growth could prompt users to compare
those figures incorrectly with others published by more conservative
companies, or to project them at the same margins and growth rates.56
PROOF
Revenue Recognition
27
Conclusion
Why do companies choose to recognize revenues aggresively? Sometimes, when young companies that have enjoyed rapid growth in sales
mature, they refuse to accept stagnating revenues and, confident that
they will be able to return to growth in the future, decide to adopt
more aggressive accounting policies that will allow them (fictionally) to
maintain the organic rates of growth they enjoyed in the past. On other
occasions, the boards of directors of listed companies provide the stock
market with results forecasts (sales and profit per share) on either an
annual or a quarterly basis. The pressure directors are under to achieve
these targets is enormous, especially since the appearance of hedge
funds that, with their leveraged strategies, can increase the volatility
of share prices if companies fail to achieve their sales and profit targets.
To respond to such pressure, directors might adopt aggressive revenue
recognition policies to achieve the figures announced to the market, or
simply reach a point somewhere in the middle with respect to the expectations of the company’s analysts. Nevertheless, they could have even
more villainous intentions. Hence, if the directors consider that failure to achieve analysts’ estimates might destabilize share prices, which
would in turn affect the value of their options on stocks or variable
remunerations, they might decide to use aggressive revenue recognition techniques to somehow ‘save the year’ at the expense of reducing
the future volume of revenues and profits.
Finally, there have been cases in which companies did not recognize
revenues by allegedly aggressive means for crooked reasons but, as we
indicated at the beginning of this chapter, because accounting standards
leave a lot of room for interpretation, and creative accounting does not
necessarily have to be illegal accounting. In this case, the problem is not
the type of interpretation but rather the fact that this interpretation and
its impact on a company’s financial statements might not be sufficiently
explicit in the annual report. In this regard, the improvement of regulations governing the information to be presented in financial statements
would be an important step towards avoiding nasty surprises. What better example of the inherent subjectivity of revenue recognition than
the case of the Spanish utility company Endesa. When subjected to a
hostile takeover by Gas Natural, which was approved by the Spanish
regulatory body, Endesa reclassified its revenues in order to declare one
third of its activity outside of Spain. In this way, it managed to get the
European Union to authorize the operation and not the Spanish regulators. Endesa eliminated revenues collected from operations between
generators and distributors, which were suddenly treated as intra-group
PROOF
28 Creative Accounting Exposed
operations. It excluded from its accounts the revenues obtained from its
mobile telephony subsidiary AUNA, which was in the process of being
sold. It worked on consolidating its French subsidiary Snet during the
whole of 2004, despite taking control in September, and recorded a200
million in revenues corresponding to costs associated with the transition
to competition in Italy. With the new figures, Endesa reduced its revenues in 2004 by a4,401 million to a13,317 million, with international
activities exceeding the 33 per cent required for Brussels to intervene.57
PROOF
Index
Note: page numbers in bold indicate entire chapters devoted to a subject.
Abengoa 118
ABN Amro 165(t)
Accor 57
accounting standards
APB 25 33
on derivatives 75–7, 78,
79–80, 81
Dutch 51
on extraordinary items 93–4
FASB see FASB (Financial
Accounting Standards Board)
international see IFRS
(International Financial
Reporting Standards);
international accounting
standards
North American 11, 24–5, 33–4,
62–3, 94, 106, 159, 175n10 (see
also FASB (Financial Accounting
Standards Board);
Sarbanes–Oxley Act)
on pension funds 103
on provisions 90–2
on stock options 33–5
UK 79–80, 98, 156
uniformity of 166, 169
Acerinox 86
acquisitions
accounting in WorldCom 144
creative acquisition accounting
144, 172n2
as factor inducing creative
accounting techniques 139–40
pooling 114, 115
pre-acquisition provisioning 144
provisions recorded during
116–17
and subjectivity in consolidation
110–18
synergies 145–6
ACS 48
Adelphia 41, 48, 148
Adidas 81
Admira Media Group 58, 64–5
agency creative accounting
123–4
agents, sales by 19
aggressive accounting in revenue
recognition 1, 3, 4, 6, 22, 26
reasons for 27–8
Ahold 13, 50–1, 112–13, 171
AIG (American International Group)
xv, 107, 165
Almunia, Joaquín 119–20
Alphameric 22
Altadis 66–7
Altera 38
Amazon 34
American Airlines 54
American Express 38–9
American International Group (AIG)
xv, 107, 165
amortization/depreciation 20, 37,
64, 88, 94, 100–1
FAS 53 and 106
of goodwill 111, 112, 115–16
Parmalat accounting scandal 132
recognition of 92–3
tax benefit 56(f)
WorldCom accounting scandal
142, 147
Analog Devices 41, 42
analysts’ forecasts 138–9, 170
AOL Time Warner 113
Apollo 41
Apple 34, 38, 40
Arthur Andersen 50, 141, 153, 157,
159
UK 146
ASML 22–3
193
PROOF
194
Index
asset recognition 82(t), 107–9
alteration of short-term assets
101
amortization see
amortization/depreciation
asset valuation adjustments
108–9
capitalization of expenses 86–8,
96–8
deferred tax assets and liabilities
98–101
definition of asset 87
intangible assets 92, 98
multi-element assets 97
pension fund 102–4, 107, 109
pooling 114, 115
real estate 97, 107
self-manufactured assets 96–7
transferred assets 156–7
Associant Technology xv
Astra Zeneca 115
AT&T 33, 49
Atos 117
audiovisual sport 65
AUNA 28
Avánzit 100
Aventis 38
Baan 21
backdating of stock options 39–41
balance sheets
‘Big Bath’ charges for cleaning up
172n2
cash flows see cash flows
defecit presentation of
non-externalized pension funds
122
Enron’s ‘asset light’ sheet 152,
157
provisions and 88–92
‘tax’ balances 99
Balfour Beatty 78–80
Banco de Santander 92
Banco Popular 92
Banesto 12
Bank of America 57, 68, 125, 129,
135, 160, 165(t)
Bank of Spain xv, 92
banking
‘Chinese walls’ 142
convertible bonds 81, 82–3
credit crisis and creative
accounting 70–1
expenses taken to equity 92
guarantees 65
hybrid instruments 77–8, 81,
82–3
off-balance-sheet financing 45–6,
65, 67–9
recognition of bank revenues 12
sale and lease back operations 57
Bankinter 12
Barclays Bank 160
barter transactions 18
Basle Committee on Banking
Supervision 68
Bausch & Lomb 16–17
Beatty, Douglas xv
Belgium: governmental creative
accounting 122
Bernett, Philip 169
‘billing and holding’ 19
binomial trees 32
Black, Fischer 32
Black–Scholes formula 32–3
BMW 91
BNP Paribas 165(t)
Bondi, Enrico 125
Bonlat 125, 126, 129, 130–1, 134–5
Breton, Thierry xiv, 168
Broadcom 16
Bucconero 127
Bush, George W. 150
Business Week 16
Caboto Holding 165(t)
CajaSur xv
Canica 50
Cannon 106
Capco 107
capital leases 51–4, 55
capital markets 72–3, 133, 141–2,
153, 168
Capitalia 136
PROOF
Index
capitalization
of expenses/costs 86–8, 96–8, 143
overcapitalization of tax shields
100–1
Carolco 106
Carrefour 57
cash-basis accounting method of
revenue recognition 7–8
cash discounts 18
cash flows 84, 104–6, 155, 177n34
free 105
investment 104–5
operating 88, 96, 104–5, 108
outflow investment or expense
criterion 87–8
Castillejo, Miguel xv
Catalonia: debt concealment 123
Causey, Richard 161
CDOs (collateralized debt
obligations) 63, 68, 69, 156
‘channel stuffing’ 19
‘Chinese walls’ 142
Chubb Insurance Co. 160
CIBC 165(t)
Cisco 33, 85, 111–12
Citigroup 68, 71, 125–6, 160, 165(t)
Coco-Cola 35, 156
Coco-Cola Bottling 156
collateralized debt obligations
(CDOs) 63, 68, 69, 156
company values
impact of accounting scandals
132–3, 146–7
impact of revenue recognition
25–6
profit quality see profit quality
compensation 31
see also remuneration
Comptronix Corp. 164–5
Consob 127, 129
consolidation
equity method of 60, 61, 116
global 62, 73, 112–13
goodwill and 111, 112, 113–16,
117, 144
holding companies and 59
pooling 114, 115
195
proportional 60, 112, 113
provisions recorded during
acquisition 116–17
revenue recognition and 11
Spanish political parties and 119
subjectivity in the consolidation of
companies 110–18
see also acquisitions; mergers
Conte, Fernando 55
convertible shares/bonds 80
mandatory/contingent 81
reclassification of 80–1
synthetic 82–3
Cook, Allan 61
cookie jar reserves 172n2
corporate governance 158, 168,
169
cost capitalization 86–8, 96–8, 143
cost reductions: recognition as
revenues 13
cost synergies 146
County of Orange 68, 76, 77
credit
credit crisis and creative
accounting 70–1
defaulted 19
sales 47
Crédit Agricole 92, 145–6
Crédit Lyonnais 92, 145–6
credit risk 45, 63, 68, 178n36
Crédit Suisse First Boston 160
critical event method of revenue
recognition 5
CSFB 165(t)
currency derivatives 131
currency mismatching 130
customs income 122
debt concealment
governmental 119–20, 121–3
Parmalat 127–9, 134
debt guarantees 49, 64–5, 127
debt instruments 65–6
deconsolidation 61, 116, 156–7
defaulted credit 19
Del Soldato, Luciano 126, 135–6
PROOF
196
Index
delivery costs, invoiced to
customers 18
Deloitte 50, 113
Deloitte & Touche 125, 126, 134
Delphi 105–6
Delta 29–30, 54
depreciation see
amortization/depreciation
derivative instruments 75–7, 82(t)
Enron and 152–3
exchange traded derivatives
(ETDs) 153
over-the-counter derivatives
(OTCs) 153
Parmalat and 128–9, 130
Deutsche Bank 77–8, 82–3, 165(t)
Deutsche Telekom 132–3
directors’ remunerations
bonuses 155
pension funds 169
stock options 41, 169
transparency in 169
discounts
prompt payment 18
recognition as revenues 13
Dixons: premature revenue
recognition 8–9
Dow Chemical 62
Dunlap, Albert J. 12–13
Dunn, Frank xiv–xv
Dupont 62
EADS 98
‘earn-outs’ 117
earnings before interest, taxes,
depreciation and amortization
see EBITDA
earnings-per-share (EPS) 84–5
analysts’ forecasts 138, 155
corporate transactions and
110–11
dilution 94–6
WorldCom 145
earnings quality 84–5, 104, 109
earnings target pressure 85
Ebbers, Bernie 137, 140, 141, 142,
148
EBITDA (earnings before interest,
taxes, depreciation and
amortization) 38, 53, 59, 60,
105, 108
Acerinox 86
consolidation and 112
EV (enterprise value)/EBITDA
146–7
Parmalat 131
WorldCom 87–8, 136–7
EDS 21
EIFT 00-21 (Revenue Arrangements
with Multiple Deliverables) 20
El Árbol Group 57
employee remunerations 31
stock options see stock options
Endesa 27–8, 108
Enron 41, 68, 69, 128, 148–63
accounting scandal chronology of
events 149–52
analysis of the accounting scandal
155–8
analysts’ recommendations on
Enron’s shares 154(t)
consequences of the accounting
scandal 158–63
money paid to investors to pay for
lawsuits 165(t)
risk factors 152–5
Enron Global Power & Pipelines 156
Enrop 41
Epicuruum 125, 129–30, 131
EPS see earnings-per-share
equity markets 72–3, 112, 133
equity method of accounting 60,
61, 116
equity swapping 60–1
Ericsson 49
Ernst & Young 141
European regulation SEC-95 122
European Union 120, 122, 123, 132
Eighth European Directive
169–70
EV/EBITDA multiple 146–7
exchange traded derivatives (ETDs)
153
exchange transactions 18
PROOF
Index
197
Parmalat and exchange losses
131–2
expense accounting 85
capitalization of expenses 86–8,
96–8
E/R (expense/revenue) ratio 146
expenses taken to equity 92
extraordinary items 93–4, 144
recognizing
amortization/depreciation
92–3
recording provisions 88–92
recurrent and non-recurrent items
94, 107
release of deferred expenses
provisions 146
start-up expenses 97
extraordinary items 93–4, 144
Exxon Mobil 34, 85–6
film industry accounting (case study)
106
financial accounting standards
see accounting standards; IFRS
(International Financial
Reporting Standards);
international accounting
standards
Financial Accounting Standards
Board see FASB
financial revenues: recognition as
revenues of sales 13–14
First Call 38
Ford 85
France: governmental creative
accounting 121, 122
Freddie Mac 76–7
free cash flow 105
futures contracts 77–8
factoring 47
Fannie Mae 123–4
FASB (Financial Accounting
Standards Board)
FAS 53 106
FAS 109 99
FAS 115 77
FAS 123 33–4, 35
FAS 133 77
FAS 146 94
FAS 148 33–4
FAS 150 63, 78, 79
Interpretation (FIN) 46 63
off-balance-sheet financing 45, 71
treatment of discounts 13
Fastow, Andrew 152, 153, 156,
157–8, 160, 162
Federal National Mortgage
Association (FNMA) 123–4
fees, non-recurrent, for recurrent
risks 18
fictitious revenue recognition
techniques 16–17
see also revenue recognition
Fields, Bill 137
FIFA (International Federation of
Football Association) 7–8
GAAP (Generally Accepted
Accounting Principles, US) 11,
24
Gamesa 6, 7(f), 115–16
Gamesa Energía S.A. 115
Gamma 30
Gas Natural 27
GE Capital 51
Gedronzi, Cesari 134
General Electric 35, 37, 57, 169
General Motors xiv, 35, 90
General Re xv, 107
‘German system’ of debt reduction
121–2
Gibson Greetings 76
GISA 123
Glisan, Ben 162
global consolidation 62, 73, 112–13
Goldman Sachs 57, 160, 165(t)
Gollogly, Michael xv
good governance 120, 132, 168, 170
goodwill 111, 112, 113–16, 117, 144
Gorelick, Jamie 123
governance
bad 140–1
corporate 158, 168, 169
good 120, 132, 168, 170
PROOF
198
Index
governmental creative accounting
119–20, 121–3
Gramm, Wendy 150
Grant Thornton 125, 126, 129,
134, 169
Greece: forging of public accounts
120
grey areas of accounting 2
Grubman, Jack 141–2
Grupo Admira, S.A. 58, 64–5
Grybauskaite, Dalia 122
guarantees 49, 64–5
HBO & Co. 16
Healtheon 16
HealthSouth 40, 41
hedge agreements 150
‘incestuous’ hedging 158
Heineken 14
Houston Natural Gas 149
Howard, Timothy 124
hybrid instruments 75, 77–83
convertibles 80–3
futures contracts 77–8
preferred stock 78–80
IAS
see international accounting
standards
IASB (International Accounting
Standards Board) 93
Iberia 55–6
ICA 50
IFERCAT 123
iFrance.com 114
IFRS (International Financial
Reporting Standards) 167–8,
173n11
FIFA’s switch to 7–8
IFRS 3 113–14, 115
IFRS 18 25
Telefónica Móviles’ switch
to 12
Immelt, Jeffrey 42
Imperial Chemical 71–2
income synergies 145–6
information asymmetry 133
ING 72
intangible assets 92, 98
integration industry:
off-balance-sheet financing 64
Intel 85
Interbrew 14
international accounting standards
ED 2 35
German standards and 75–6, 91
IAS 1 93–4
IAS 3 91–2
IAS 16 93
IAS 19 35
IAS 27 64, 71
IAS 32 80
IAS 37 90–1, 92
IAS 38 98
IAS 39 75–6, 77
IFRS see IFRS (International
Financial Reporting Standards)
revenue recognition and 5, 14,
15, 19, 21, 25
special purpose entities/vehicles
159
UK standards and 79–80, 98
International Accounting Standards
Board (IASB) 93
International Financial Reporting
Standards see IFRS
InterNorth 149
Intesa 136
inventories 85–6
provisions and 88–92
Inversión Corporativa 118
investment cash flow 104–5
IRUs (indefeasible rights of usage)
18
Italy: governmental creative
accounting 122
Jazztel 108
Jeronimo Martins (JM) 112(t), 113
Jeronimo Martins Retail (JMR)
112(t), 113
Johnson, James 123–4
J.P. Morgan 68, 69, 159–60, 165(t)
Jurado, Fransisco xv
PROOF
Index
Kanebo xv
KarstadtQuelle AG 57
Koenig, Mark 155, 161, 162
Kopper, Michael 159, 160
Korologos, Ann McLaughlin 124
Koyo & Co. xv
Kozlowski, L. Dennis 171
KPMG 117
launch aids 5
Lay, Kenneth 149, 150–2, 153, 158,
160, 161, 162, 171
leadership
corporate culture and 153
personalized 140–1
leases
in aviation industry 55–6
capital v. operating 51–6
sale and lease back operations
57
synthetic 54–5, 56 (f), 63
Lehman Brothers 160, 165(t)
Levitt, Arthur xvi, 89, 172n2
licence amortization 93
licence sales 17–22
Lie, Eric 40
LIFO valuation system 85–6
limited life partnerships 63
Livedoor xv
LJM 158–9
LJM1 157–8
London Bridges Plc 22
Long Distance Discount Services
(LDDS, later WorldCom)
137
long-term receivables 19
L’Oréal 116
Lucent Technologies 33
Madrid: debt concealment 123
Mamoli, Adolfo 134–5
mandatory convertibles 81
Marlborough Stirling Plc 22
Maxim Integrated Products 38
McAfee 41
McGuire, William 41
199
MCI 138, 140, 145, 148
McKinsey 170
McLaughlin Korologos, Ann
124
McNulty, Paul J. 163
mergers
as factor inducing creative
accounting techniques
139–40
recognizing sales incorrectly
deferred during 17
simulated by pooling 114
and subjectivity in consolidation
110–18
Merrill Lynch 71, 157, 160
Messier, Jean Marie 108, 114
Metallgesellschaft 68
Metro 57
Meurs, Michiel 171
MG Refining and Marketing (MGRM)
75
Micron Technology 39
Microsoft 16
stock options 33, 34, 35, 38, 42
Microstrategy 22
Microwave Communication Inc.
(MCI) 138, 140, 145
Mintra 123
Mizuho 165(t)
monster.com 41
Morgan Stanley 135
Motorola 85
Mulford, Charles W. 164–5
Muskovwitz, Karla 160
My Travel Plc 5
Myers, David 148, 157
National Semiconductor 38
Next Wave 49
Nextra 135
Nicolalsen, Donald 166
Nokia 6, 43
non-consolidated entities 61, 128
Enron accounting scandal 155–6
SEC requirements 63
Nortel xiv–xv, 89–90, 91
North xv
PROOF
200
Index
North American Accounting
Standards Board 107
see also FASB (Financial Accounting
Standards Board)
Novartis 36, 82–3
off-balance-sheet financing 44–74
banking sector 45–6, 57, 67–9
capital leases v. operating leases
51–6
changes in working capital 47–8
debt guarantees 49, 64–5
equity swapping 60–1
factoring and credit sales 47
identification from company
financial statements 72–4
obligations 48–51
off-balance-sheet debt 127–9,
134
parking of shares 60
sale and lease back operations 57
securitization 65–7, 68
special purpose entities/vehicles
and 54–5, 61–4
in the systems integration industry
(case study) 64
Office of Federal Housing Enterprise
Oversight (OFHEO) 123
Olivetti, Wanderley 134, 135
Omnicom 117
ONO 97
operating cash flow 88, 96, 104–5,
108
operating leases 51–6
operating profits, inflation of
13–14
Orion Pictures 106
over-the-counter transactions (OTCs)
68, 153
overcollateralization 177–8n34
parking of shares 60
Parmalat 14, 64, 125–36, 171
analysis of the accounting scandal
127–33
causes behind accounting risk
126–7
consequences of the accounting
scandal 133–6
impact of accounting scandal on
company value 132–3
Parmalat Participaçoes 128
pension funds 102–4, 107, 109
defecit presentation of
non-externalized 122
directors’ remunerations 169
percentage of completion method of
revenue recognition 6
Pernod Ricard 101
Perot Systems 21
personalized leadership 140–1
Peugeot 72
Philips 29
Pitt, Harvey 148, 166
Ponzi method 120
potential losses 172n2
Powers Report 162
Powers, William 162
pre-acquisition provisioning 144
preferred stock 78–80
premature revenue recognition
8–12, 172n2
Priceline (priceline.com) 26
‘pro forma’ accounts 94–6
Procter & Gamble 35, 68, 76, 95–6
profit quality 84, 86, 109
accounting income 170
cash flow and 84, 104–5
earnings quality 84–5, 104, 109
prompt payment discounts 18
proportional consolidation 112,
113
provisions in accounting 88–92
public entities: creative accounting
119–24
Publicis 77
Puleva 117
pyramid fraud 120–1
Raines, Franklin 124
Rajappa, Sampath 124
Raptor 162
rating agencies 73, 128
Raytheon 49
PROOF
Index
real estate investment vehicles 97,
107
Recoletos 95
REFCO 169
REITS (real estate investment
trusts) 63
remuneration
directors’ see directors’
remunerations
through restricted shares 42
stock options see stock options
types of employee remuneration
31
Renault 5
RENFE (Red Nacional de los
Ferrocarriles Españoles) 59
Repsol 102
research and development costs
98
reserves 101–2
revenue allocation method of
revenue recognition 6–7
Revenue Arrangements with Multiple
Deliverables (EIFT 00-21) 20
revenue recognition 1–28
accounting standards and 5, 11,
14, 15, 19, 21, 24–5
aggressive 1, 3, 4, 6, 22, 26,
27–8
cash-basis accounting method
7–8
in cost reductions 13
critical event method 5
financial revenues as revenues of
sales 13–14
how to detect doubtful revenues in
company accounts 23–4
impact on the value of companies
25–6
Lucent Technologies 1, 2(f)
methods and associated problems
3–8
percentage-of completion
method 6
premature 8–12, 172n2
problematic areas in the
recognition of sales 18–19(t)
201
recognition of bank revenues 12
revenue allocation method 6–7
from sales of licences in the
software industry (case study)
17–22
sell-in revenue method 20
sell-through revenue method 20
in the semiconductors sector (case
study) 22–3
taxes as sales 14
techniques 5–8, 14–16
techniques for recognizing
fictitious revenues 16–17
timing and 3–4, 5
transfer of risk and 4–5, 26
without transfer of sale risk or
payment obligation 12–13
WorldCom accounting scandal
143
Rhodia xiv, 168
Richemont 116
Rieker, Paula 161
Rigas, John 148, 170–1
Rigas, Timothy 148, 171
risk management 75–83
derivative instruments and 75–7,
82(t)
hybrid instruments and 75, 77–83
risk premium 133
risk transfer criterion see transfer of
risk
Roberts, Kent 41
Roche 36
Rolls-Royce 5
Royal Bank of Canada 160
Royal Bank of Scotland 160
Royal Dutch Shell 101–2
RTVE (Radio Televisión Española) 59
SAB 101 accounting standard 24
sale and lease back operations 57
sales
by agents 19
aggressive interpretation of see
aggressive accounting in revenue
recognition
of licences 17–22
PROOF
202
Index
sales – continued
problematic areas in the
recognition of 18–19(t)
revenue recognition see revenue
recognition
transfer of risk 4–5, 12, 26
sales returns 18
Salomon Smith Barney 141–2
Sanofi 25, 38
Sanofi-Aventis 116
SAP 6, 32
Sarah Lee 88
Sarbanes–Oxley Act 40, 63, 148,
166–7
SARs (stock appreciation rights)
31, 32
SAS xvi
Scholes, Myron 32
Scrushy, Richard 40, 170
SEC (Securities and Exchange
Commission) 172n1
and Delphi 105–6
directors’ remunerations 169
fines and settlements 2002–2005
165–6
fining of Al Dunlap of Sunbeam
12–13
fining of Lucent 1
fining of Xerox 9
introduction of SAB 101
standard 24
investigation of EDS 21
investigation of Repsol 102
litigation against Tanzi 135
non-consolidated entity
requirements 63
‘Q’ regulation and ‘pro forma’
accounts 95
Securities and Exchange Commission
see SEC
securitization 65–7, 68
Seita 66–7
sell-in revenue method of revenue
recognition 20
sell-through revenue method or
revenue recognition 20
semiconductors sector: revenue
recognition 22–3
share parking 60
shareholders: abuse of minority
shareholders 118
side letters 16
Siebel Systems 39
Silicon Valley 34, 54
Singapore Airlines 54
SIVs (structured investment vehicles)
70
Skilling, Jeffrey 149, 150, 153, 155,
158–9, 160, 161, 162, 171
Snet 28
software industry: revenues from
sales of licences 17–22
Software Revenue Recognition (US
Statement of Position 97-2)
20, 22
Sogecable 15–16, 49–50
Sogepaq 49, 50
SOP 97-2 statement 20, 22
Spain: debt concealment 123
Spanair xvi, 100
Spanish banks 92
Spanish National Audit Office 119,
121–2
special purpose entities/vehicles
(SPEs/SPVs) xv, 54–5, 61–4,
65–7, 71, 73
accounting standards and 159
cash flows and 177n34
Enron accounting scandal 156–8,
159
SPEs/SPVs see special purpose
entities/vehicles
Sprint 138
ST Microelectronics 38, 80–1
start-up expenses 97
Stewart, Martha 170
stock and inventory variations
85–6
stock appreciation rights (SARs)
31, 32
stock options 29–43
accounting as expenses 29–30, 37
backdating 39–41
PROOF
Index
company reasons for issuing
36–7
definition and use 30–2
directors’ remunerations in 41
history of 33–6
hybrid instruments and 77–8
impact on company valuation
37–9
US accounting standards 175n10
valuation methods 32–6
stock tracker 145
stockpiling 86
structured investment vehicles (SIVs)
70
Studiocanal S.L. 49, 50
subsidy payments 5
Sullivan, Scott 137, 140–1, 143,
145, 148
Sun Microsystems 39, 99
Sunbeam 12–13, 14–15
sunk costs 142
surety bonds 69
Surugaya xv
Swiss Re 160
synergies 145–6
synthetic convertibles 82–3
synthetic leases 54–5, 56 (f), 63
Tanzi, Calisto 125, 127, 132, 135,
171
Tanzi, Giovanni 136
Tanzi, Stefano 136
tax havens 126
taxes
deferred tax assets and liabilities
98–101
recognition as sales 14
tax shields 52, 55, 56, 64, 98–9,
100–1
Telefónica Móviles 12, 24, 29, 58–9,
60, 64–5
Telepizza 95
Tetra Pak 134
Thai banks 65
3Com 17
Time Warner 166
AOL Time Warner 113
203
Toikka, Kari 111
Tokyo Mitsubishi 165(t)
Tonna, Fausto 125, 134, 135–6, 171
Toronto Dominion Bank 160
transfer of risk 4–5, 26
Sunbeam and the risk transfer
criterion 12
transfer prices 117
transferred assets 156–7
transparency 117, 169
Treadway Commission 3
Turner, Lynn 40
Tyco 37, 41, 68, 169, 184n21
UAL 54
UBS 165(t)
unconditional purchase obligations
48–9
Unilever 29
United Kingdom
accounting standards 79–80, 98,
156
governmental creative accounting
122
UnitedHealth 41
Universal Vivendi 108
UPM Kymmene 111
US Robotics 17
Valencia: debt concealment 123
valuation methods
inventories 85, 179n6
stock options 32–6
van der Hoeven, Cees 171
Vía Digital 58–9, 60
Vivendi Universal 114–15, 128
Vodafone 11, 24, 93
Wall Street Journal 9, 40
Walsh, Frank 169
Watkins, Sherron 151
Watson Wyatt 122
Welch, Jack 169
Wessex Water Services 161
West LB 165(t)
Whiteline 157
PROOF
204
Index
WorldCom 41, 73, 87–8, 128,
136–48
analysis of the accounting scandal
143–6
circumstances that cause the
accounting scandal 138–42
consequences of the accounting
scandal 147–8
impact of accounting scandal on
stock market value: the EV/EBITA
multiple 146–7
money paid to investors to pay for
lawsuits 165(t)
Xerox Corporation
Xfera 118
Xilinx 38
Yates, Buford
YPF 102
Zecoo
xv
148
7, 9–11